Amazing, seems like this one rating agency has been way more positive about Chicago debt than the other more established firms. Hmm, I bet if someone looked into there might be something missing from this story, something in a press release from Oct 2017.

Wow, another article missing a key fact about this story. I mean a double bond rating upgrade for Chicago out of the clear blue, why would Kroll do that?

Last chance, you would think the wonks at P&I would have picked up on the one thing about Kroll that would tie this whole Chicago double upgrade together. Nope.

NEW YORK--(BUSINESS WIRE)--Kroll Bond Rating Agency (KBRA) is pleased to announce the appointment of Lois Scott as the most recent member of its board of directors.

Lois currently serves on the board of the Chicago Stock Exchange (Chair, Audit Committee, Regulatory Oversight Committee), the Federal Home Loan Bank of Chicago (Audit and Risk Management Committees), and the advisory boards of other privately held financial services companies. From 2015 to 2017, she served on the board of MBIA Inc. (MBI – NYSE, Audit Committee and Finance and Risk Committee). She is Chair of the Advisory Board of the Center for Municipal Finance at the Harris School of the University of Chicago, co-founder of the Municipal CFO Forum, a founding board member of Retirement Security Initiative, and is well known as one of the founders of Women in Public Finance.

From 2011-2015, Lois served as the Chief Financial Officer for the City of Chicago, where she had financial oversight of essential City services as well as O’Hare Airport, Midway Airport, the City’s public-private infrastructure partnership contracts, and water and wastewater systems. Lois brought corporate-style investor relations and enhanced disclosure to municipal government, launching the City’s annual investor conference in 2011. Lois is also a frequent speaker on the financial sustainability of state and local government, she also served as special advisor to the Clinton Global Initiative on infrastructure.

In addition, Lois was named the “100 Most Influential People in Government” by Crains for multiple yeas in a row and the “Freda Johnson Trailblazing Woman Award,” by the Northeast Women in Public Finance in 2014. Lastly, she was also named “Woman of the Year,” at the Women in Public Finance national conference in 2011.

"We are delighted to have Lois join KBRA as a member of our board. She brings a deep understanding of credit, strategic and entrepreneurial approach, as well as decades of experience managing finance organizations,” said Jim Nadler, President and CEO.

I decided to look for Scott in this very thread. I found a few posts in which she kept dinging Moody's downgrade of Chicago back in 2014:

Following its annual outlook on the state’s financial situation, the Wall Street agency’s decision to upgrade the city from a BBB+ to an A “reflects identification and dedication of permanent ramp-up revenue sources to address severely underfunded pensions, and KBRA’s expectation that addressing these pension obligations long term will prove to be affordable and sustainable for the city’s wealth base.”

Chicago Mayor Rahm Emanuel expressed his gratitude for Kroll’s upgrade, calling it a reflection of “seven years of work to put our pensions on a path to solvency, address legacy debt issues, and reduce the structural budget gap.”

“While there is still more work to do, today Chicago is on firmer financial footing because we came together to address the financial challenges we inherited with real solutions,” he said in a statement. “Today, as a result, we can invest in Chicago’s future with certainty, we can provide taxpayers certainty about the city’s direction and we can provide businesses the certainty they need to create more jobs for residents across the city.”

This revelation is a head-scratcher, as Moody’s Investors Service nearly downgraded the city to “junk” bond status last year. According to the Chicago Tribune, Moody’s is still categorizing Chicago’s debt as such. In addition, the Illinois pension system was under 40% funded in the last fiscal year.

While Kroll agreed with Moody’s sentiments that annual contributions will need to increase significantly from 2020 to 2023, with hopes that Chicago can collect $864 million more per year by 2022, it showed more optimism than Moody’s in terms of Chicago getting the job done.

“KBRA believes the City’s management team has been proactive in implementing necessary measures to stabilize and improve financial operations. This follows a period characterized by structural budget deficits and the use of non-recurring sources in the prior administration,” Kroll said in a statement. “KBRA notes that Chicago exhibits characteristics of an important world business center and houses one of the world’s largest and most diversified economies.”

Most recently, Illinois lawmakers have been entertaining the idea of a bond sale larger than its entire obligations, but it’s unlikely that the measure will pass should the state’s Republican Gov. Bruce Rauner be re-elected come November. However, coupled with other credit agencies following Kroll’s bold upgrade, the bond sale would have a higher chance under a Democratic administration.

The Chicago Tribune on Tuesday reported that the Kroll Bond Rating Agency increased its rating for the city of Chicago. The article informs us of the reasoning behind Kroll’s decision, and also how Chicago Mayor Rahm Emanuel appreciated this vote in favor of his financial leadership.

However, the article should be read cautiously.

A credit rating debt upgrade by one firm does not necessarily mean Chicago’s credit quality really improved. If we learned anything from the 2007-2009 financial crisis, bond ratings should not be taken at face value.

Kroll cited the city’s efforts to shore up underfunded employee pension funds as a reason for its upgrade. This may improve credit quality, of course, but improvements for bondholders are not always in the interest of taxpayers and residents.

Higher taxes do not necessarily improve a taxpayer’s financial position.

Kroll upgraded the city two notches, from a BBB+ to A. But those ratings are both at the lower end of “investment grade” ratings. When the average citizen sees that Chicago is now an “A,” they probably need some more context to understand that this does not mean Chicago has gone to the head of the class. Credit rating firms also issue AA and AAA ratings.

Credit rating agencies are not government agencies. They are private-sector firms paid by the issuers of debt, and in this case, the city of Chicago. Their ratings gain regulatory authority because financial regulators have chosen to include their ratings in financial regulation—a practice with a very checkered history, but one that persists today. This might help to explain why BBB+ and A look good on surface, compared to C, D, and F grades, but they are not necessarily great ratings.

The Tribune article stated that “if other agencies eventually follow suit, the city could end up paying less interest on future borrowing.” This indicates that our media apparently has yet to learn “chicken or the egg” lessons from financial markets. They may still give too much credit to bond rating firms for the value of their opinions. Credit ratings often lag, not lead, financial market prices. In other words, Chicago’s interest on future borrowing may fall in the future, in either absolute or relative terms, but credit rating changes may simply reflect market forces already underway.

More fundamentally, even if the fortunes of bondholders are indeed improving, and the credit rating accurately reflects that improvement, this does not necessarily bode well for the average taxpayer.

Investors may now face a “small risk of loss,” according to Kroll. But for taxpayers it isn’t a matter of risk or probabilities. Their taxes—payments for the city’s dismal financial condition—are certainly going up.

So much for high hopes that a double-upgrade in Chicago’s general obligation bond rating by a small Wall Street rating agency would trigger similar increases by the bigger players, reducing borrowing costs.

The best Standard & Poor’s could do Friday is reaffirm Chicago’s BBB+ general obligation bond rating and raise the rating on the city’s 1997 G.O. “limited tax building acquisition certificates”– from BBB+ to BBB. The certificates are “payable from legally available funds and are not secured by a debt service levy,” the report states.

Mayor Rahm Emanuel has done that by “increasing pension contributions and statutory requirements to fund pensions on an actuarial basis,” eliminating scoop-and-toss borrowing and reducing the city’s once-heavy reliance on “non-recurring revenues” with a commitment to eliminate the structural deficit by 2019.

But Spain said the warning flags simply cannot be ignored. They are: Chicago’s “high fixed costs tied to its liabilities;” “significant” and fast-rising rising public safety expenses tied to a two-year plan to hire 970 additional police officers and “distressed overlapping governments” like the Chicago Public Schools that “will likely continue to challenge” the city’s “fiscal sustainability.”

“We therefore view Chicago as being at a crossroads. While our rating and outlook assume the city will maintain its current course emphasizing structural solutions to address growing liabilities, the practical reality remains that the city needs to maintain the political will and resources to address the challenges or credit quality will also reverse its trajectory,” Spain was quoted as saying.

Chief Financial Officer Carole Brown maintained that Chicago is “in a better financial position today” than it was when Emanuel took office and that S&P acknowledged that nearly two years ago by changing the outlook on the city’s general obligation bonds from negative to stable.

“Based on S&P’s criteria, our rating was capped at the current rating of BBB+, so the City was not anticipating an upgrade at this point,” Brown was quoted as saying in a statement.

“We will not stop our deliberate work to improve our long-term financial condition while continuing to grow our economy and make critical investments citywide.”

Chicago taxpayers have paid a heavy price, just to begin to solve the city’s $36 billion pension crisis.

They have already endured $1.2 billion in property taxes for police, fire and teacher pensions; a 29.5 percent tax on water and sewer bills for the Municipal Employees Pension Fund, the largest of the four; and a pair of telephone tax increases for the Laborer’s pension fund.

More tax increases are on the way. By the city’s own estimates, police and fire pension costs will rise by $297.3 million or 36 percent in 2020. The Municipal and Laborers plan costs will grow by $330.4 million or 50 percent in 2022. Emanuel has not said how he plans to close those gaps.

In raising Chicago’s bond rating by two notches this week, Kroll Bond Rating Agency acknowledged the need to “identify funding sources” for four city employee pension funds “once the interim period ends and full actuarial funding begins.”

But Kroll’s managing director Harvey Zachem said the mayor and City Council have already demonstrated the political will to confront the challenge.

“They did implement a very large, $543 million property tax levy increase and pretty substantial water and sewer usage tax increases also. We do see that as an indication of willingness to take on the 2020 and 2022 spikes,” Zachem said.

“If they were a non-home-rule unit, they’d be limited to mostly the property tax and they’d be capped…[But] they do have options with home-rule status. We would expect some combination of sources to be used.”

Kroll managing director William Cox referred to the in-depth study Kroll published last summer about the city’s pension crisis. It examined Chicago’s tax and wealth base and compared it to nearby suburbs and other large cities.

“We looked at the impact of various taxes, fees and charges and compared that to income levels of both households as well as size of businesses,” Cox said.

“Our conclusion was that Chicago, while it has a growing overall tax burden, that burden is still relatively modest compared to others in the suburban ring, as well as others across the country.”

What's Ahead For Chicago: Forced Tax Increases And Priority For Pensions And Bonds - Wirepoints Original

Spoiler:

A new bill pending in the General Assembly provides a nice reminder of how bad off taxpayers and service recipients would be in Chicago if there’s not enough money to cover everything. Property tax increases are now mandated by state law, gradually ramping up to whatever-it-takes amounts to fund the city’s pensions. The bones are being picked over multiple times by pensions and bondholders. When things hit the fan, there won’t be much money left for anything else. The bill also illustrates an interesting question about payment priorities between pensions and bonds.

The General Assembly earlier prioritized pension contributions over services by providing that, if Chicago ever fails to remit the annually required contributions to its pensions set by state law, the shortage could be subtracted out of funds that flow from the state to the city. That flow of money is in the billions and is critical to the city. The state must then deposit those amounts into the pension that got shorted. In other words, money such as the city’s share of sales taxes would be intercepted and used for pensions instead of other city needs.

The new bill, HB 4224 is sponsored by Rep. Robert Martwick, a Chicago Democrat. It adds a requirement that rules made by the Comptroller will guide any interception of state money for the Laborers’ fund, one of Chicago’s four pensions. That would be Chicago Democrat Susana Mendoza. How nice.

The bill also changes the language about the Comptroller putting money into the pension from “deposit” to “remit.” The purpose of that change isn’t clear. I emailed Martwick for an explanation but got not answer. Maybe it’s unimportant, but that’s not the point. Instead, think of this as a reminder of what’s going on.

All four Chicago pensions now have basically the same protection as the Laborers’ fund, allowing for that interception of state money, which is critical for Chicago.

More importantly, all four pensions are now also protected by state law that mandates a Chicago property tax increase to cover the drastic up-ramp in scheduled pension contributions. Those mandatory property tax increase got virtually no press coverage, but it’s true. You can see an example of the mandatory language yourself in line 9 of the existing law, which is also shown with the bill: “the city council of the city shall levy a tax annually [to meet the ramp].”

Similar mandatory tax increases protecting Chicago’s police and firefighter pensions were added in 2016, as we described earlier. For the fourth pension, the Municipal fund, Chicago Democrats snuck the automatic tax increase into last year’s 756-page budget implementation bill (beginning around page 380) that most lawmakers had only hours to review.

So, Chicago Dems have prioritized pensions in two ways — forced property tax increases and the interception of state money.

And what is the pension contribution schedule that’s protected? It’s this huge ramp up, which Chicago finally published last year:

Be aware, however, that we really don’t know how far up that ramp will go. Beginning in 2022 and 2023, the requirement is a form of ARC — actuarially required contribution. That basically means it’s whatever it takes to get the pensions to 90% funding 25 years from then.

“Hold on a minute,” you might ask. Didn’t the state also just put bondholders first by authorizing a new form of bonds backed by sale of money owed to cities by the state? Yes, it’s intended to work even in bankruptcy. We wrote about that new law as it moved through the legislature and many others have since (one Bloomberg article is linked here.

What’s interesting is that the authorization also included a “non-impairment” provision, which basically says the state must refrain from doing anything that would undermine the new structure protecting bondholders’ ownership of money coming from the state. Doesn’t that conflict with the law that allows the Comptroller to intercept those same monies to pay pensions?

It seems like a conflict to me but I haven’t seen the issue discussed. Chicago’s new bond issue provides for the sale of up to $3 billion of sales tax revenue that comes to it from the state. Who would get that money if Chicago started defaulting, bondholders or pensions through the Comptroller intercept? I can’t tell.

The point here is that pension protectors and the municipal bond juggernaut have been aggressively passing into law whatever they can to ensure they come first if the city doesn’t have enough money for everything.

Who’s doing the same for taxpayers and those who rely on city services? Not Chicago Democrats.

CHICAGO – Authorization for as much as $2 billion in O’Hare International Airport borrowing may be introduced to the Chicago City Council as soon as Wednesday along with an $8.5 billion terminal makeover and expansion plan, sources said.

The bonding ordinance has been in the works for some time and the financial team of underwriters, advisors, and bond counsel were selected earlier this year, multiple public finance sources said. The ordinance must face a Finance Committee hearing before being voted on by the full council.

It’s unclear how much of the deal would finance a multi-year capital improvement program, remaining costs associated with an ongoing reconfiguration and expansion of the airport’s runway projects, and the new terminal program under negotiation with airlines.

The city is in final negotiations on the $8.5 billion terminal overhaul with the airlines at O’Hare and it could be introduced Wednesday.

“This is a game-changer for the city of Chicago,” Mayor Rahm Emanuel said during a public appearance Monday. “This is a once in a lifetime moment to literally leapfrog the competition and become in the United States, the gold standard of what a modern transportation/aviation system looks like…for me this is essential for the vitality of the city.”

On the overall financing plans for the new terminal program, city finance department spokeswoman Molly Poppe said: “The administration will have more detail on the financing in the very near future, but as a general matter, this project will be paid for using traditional airport financing mechanisms, and it will not rely on any taxpayer dollars.”

The city uses passenger facility charges and a general airport revenue bond structure to finance projects at O’Hare and Midway International Airport. The current airline lease and use agreement expires in May so the financing would be built into the new pact.

Poppe would not confirm information on the bonding authorization that sources said was expected to be submitted Wednesday and declined to discuss the size, timing, structure, or security until it’s submitted to the council.

The terminal package has been the subject of negotiations between the Aviation Department and airlines for more than a year and would mark a followup to the ongoing O’Hare Modernization Program launched by Emanuel’s predecessor Richard M. Daley in 2001.

That $10 billion program focused on reconfiguring the airport’s runways to a parallel design in place of the intersecting setup blamed for frequent weather delays. Airlines resisted funding a new western terminal that was part of the original plan.

Emanuel in early 2016 announced funding agreements on the final sixth runway. Emanuel later in the year announced his plans to pursue a terminal revamp when airlines signed off on the $300 million expansion of one terminal and additional gates. American Airlines (AAL) and United Airlines operate hubs at the airport and account for about 80% of flights.

Aviation Commissioner Ginger Evans has argued terminal upgrades and new gates are needed to remain competitive internationally and relieve congestion now that there is additional flight capacity.

The plan calls for major renovations to Terminal 1, 3, and 5 and the demolition of Terminal 2, which would be replaced with a new international terminal to supplement the existing international facility and be able to accommodate larger aircraft.

New concourses, parking, security screening facilities, and an underground tunnel are part of the eight-year program.

The city is also still pursing efforts to build new hotels and upgrade an existing hotel and is reviewing the qualifications of four firms or teams that have expressed interest in a public-private partnership to build and finance an express rail line between downtown Chicago and O’Hare.

Chicago’s airport credits have fared well in the market compared to the steep penalties it pays on its lower rated general obligation credit.

Chicago sold $812 million of GARBs last June. Ahead of the sale, Fitch Ratings and S&P Global Ratings affirmed O’Hare’s single-A level ratings on both its $7.28 billion of general airport revenue bonds and $560 million of passenger facility charge debt.

The airport has a $2.3 multi-year CIP program and about $1.6 billion in remaining runway costs, Fitch said. In June, the rating agencies said $8.9 billion in GARB debt was expected to be sold over the next five years.

Moody’s Investors Service and Kroll Bond Rating Agency – which rate the airport’s GARBs at A2 and A-plus, respectively -- were not asked to rate the June issue.

Airline cost per passenger, are moderate for a large hub airport at under $15 but are expected to rise above $20 over the next five years.

A 10-year non alternative minimum tax maturity with a 5% coupon on the June sale landed at 2.3%, a 44 basis point spread to the market opening Municipal Market Data’s AAA benchmark with a long 2041 non-AMT, 5% coupon maturity landing at 3.28%, a 65 bp spread.

A 10-year maturity on Chicago’s $1.1 billion O’Hare sale just after the 2016 presidential election landed at an 82 basis point spread to the MMD top benchmark. In a $1 billion sale just before the election, the 10-year landed at a spread of 58 basis points. Both were in non-AMT series.

The airport has recently ranked third nationally in passenger count, behind Atlanta and Los Angeles.

Taking a Risk: Explaining the Use of Complex Debt Finance by the Chicago Public Schools

Spoiler:

By Amanda Kass (University of Illinois at Chicago), Martin J. Luby (University of Texas at Austin), and Rachel Weber (University of Illinois at Chicago)

For most of the 20th century, the municipal securities market was a sleepy backwater where governments went to raise money for roads, bridges, and wastewater systems. Most cities financed their infrastructure with debt that relied on conservative or well-seasoned market structures. At the end of the century, however, local governments entered a period of “entrepreneurial” finance as federal support for urban development declined. In the years leading up to the global financial crisis, many US governments began utilizing new bond structures and riskier financial instruments to, potentially, lower borrowing costs.

We focus on one such novel instrument: auction rate securities (ARS), which are often paired with interest rate swaps. Unfortunately, the market for these securities seized up in 2008, and the risks of ARS were realized in penalty fees and a spike in borrowing costs, exacerbating the fiscal stress governments were already experiencing due to the Great Recession. We seek to explain why some local governments gravitated toward instruments with greater financial risks while others did not. Our case study of the Chicago Public Schools develops new propositions about why local governments, as organizations, take varied approaches to financial management. The Chicago Public Schools floated about a $1 billion in ARS, and, as such, represents an extreme case of financial risk-taking.

What kinds of organizational dynamics might influence the degree of risk a local government is willing to accept in its debt issuances? We frame our discussion in terms of the layered principal-agent relationships that influence issuer behavior, focusing on two main dynamics: (1) moral hazards that arise from unaligned risk preferences, and (2) information asymmetries concerning actual financial risks. Moral hazard occurs when government issuers, innocently or willfully, ignore the risk preferences of their principals in the use of complex financial instruments. Information asymmetries are present when governments lack knowledge about the risks involved in these instruments, particularly compared with their private-sector partners.

In Chicago, the Mayor appoints the Board of Education and has significant power over the district. Because of the hierarchal and insulated nature of the CPS’s administration, financial managers operated in an environment devoid of knowledge about the risk preferences of taxpayers – other than the fact that they generally dislike them but also want high-quality services and facilities. As such, CPS financial administrators lacked knowledge about whether voters preferred that they minimize risk and better utilize existing school buildings, or take on new debt and more risk to fund new construction. CPS, we argue, innocently ignored the risk preferences of its principals.

We also find evidence of a “willful neglect” type of moral hazard. The use of financing techniques like ARS fits into a larger pattern of the City’s debt management in the 1990s and 2000s. During Mayor Richard M. Daley’s tenure (1989-2011), the City’s primary economic development program was Tax Increment Financing, which relies on revenue bonds, displaces tax rate increases to other taxing bodies, and gives the illusion that development “pays for itself.” It also leased the Skyway (a seven-mile tolled highway) and parking meter system through public-private partnerships in 2005 and 2008, respectively. Both concessions generated revenues used primarily to fund short-term operating budget deficits while turning over potential windfall revenues to private operators for the subsequent 75-99 years. Considering the City’s history of discounting future risks and costs, the case of CPS’s use of ARS does not look out of place.

The case lends weaker support for information asymmetries as the key driver of CPS’s debt management decisions. On one hand, the district’s experienced board and management team were knowledgeable about the risks involved in ARS. The chief administrative officer, in charge of overseeing CPS’s borrowing strategy, was a former CEO of the Chicago Board of Trade and director of an investment firm. Several other Board of Education members came from the world of investment banking. Given their previous experience leading large private sector financial institutions, they were comfortable utilizing complex financial instruments for CPS in light of its need for additional resources.

In terms of information asymmetries caused by some incompetent advisory services and/or self-dealing bank behavior, the answer is less clear. While CPS’s advisors informed it of the fact that investment banks were not just selling but also purchasing ARS securities to keep the market afloat, CPS may not have understood the extent of this phenomenon. This ignorance could be the fault of CPS: a focus on past success may have kept them from incorporating the possibility of real danger. Or the ignorance could be due to intentionally duplicitous behavior by banks, which possessed more information than they shared with issuers about the ways they were propping up the ARS market through their own purchases of these securities. Unfortunately we lack evidence to determine whether optimism or calculated misconduct was at fault. However, the decades of financial expertise at CPS leads us to believe that information asymmetries contributed less to risk-taking by CPS than moral hazards, i.e., the fact that CPS was being run by a multi-term mayor and private sector professionals that could shift the risks of the district’s debt management strategy to other (future) stakeholders.

While ARS are unlikely to be used the same extent again, this case is illustrative of a more generalized phenomenon of governments drifting toward more complex and risky financial instruments. Governments have moved from relying on general obligation bonds with fixed rates to variable rate instruments to less-seasoned securities paired with derivatives. It is not surprising that several local governments – from Detroit to Jefferson County, Alabama to transit authorities in San Francisco and New York City — have experienced collateral calls and terminations of their interest rate swaps, which has triggered hundreds of millions of dollars in penalties and costs as well as subsequent service cuts and austerity measures. Understanding the motives of administrators and the political and fiscal contexts for adoption may help anticipate which governments will embrace the next financial ingenuity promising to cater equally to investors, issuers, and taxpayers.

Read the article here.

—

Amanda Kass is a PhD student in the Urban Planning and Policy department at the University of Illinois at Chicago. She is the Assistant Director of the Center for Municipal Finance at the University of Chicago’s Harris School of Public Policy.

Martin J. Luby is an assistant professor in the LBJ School of Public Affairs at the University of Texas-Austin. His teaching and research broadly focuses on public finance with an emphasis in public financial management. Much of his research has focused on the use of debt finance by US governments including topics such as innovative government financial instruments, federal financing techniques, and municipal securities market regulation.

Rachel Weber is a professor in the Department of Urban Planning and Policy at the University of Illinois at Chicago. Her research focuses on the relationship between capital markets and the built environment. Her latest book, From Boom to Bubble: How Finance Built the New Chicago (University of Chicago Press, 2015), won the 2017 Best Book in Urban Affairs Award from the Urban Affairs Association.

Taking a Risk:
Explaining the Use of Complex Debt Finance by the Chicago Public Schools
Abstract: In the decade leading up to the global crisis of 2007-2008, local governments in the United
States used more complex financial structures to underwrite major capital projects. These structures
offered potentially lower borrowing costs while also carrying greater financial risk, and in most cases, the
bond structures imploded when the crisis hit. Why did some local governments gravitate toward this part
of the risk spectrum while others did not? This paper develops several explanations for local government
risk-taking with a case study of the Chicago Public Schools’ use of auction rate securities and interest rate
swaps. We argue that the school district’s exceptional use of these instruments was due to administrators’
familiarity with these instruments, Chicago’s long history of using creative financing techniques to defer
tax increases or service cuts, and lack of knowledge about the extent to which investment banks were
propping up these debt markets.
Key words: fiscal policy, municipal bonds, financial innovation, risk management, urban education

CHICAGO – With its near-term fiscal strains eased by an infusion of new annual state funding, Chicago Public Schools plans to return to the market with an up to $600 million general obligation refunding.

“We expect this issuance to refund existing bonds at a lower interest rate. There is no debt restructuring or new money,” said CPS spokesman Michael Passman. A past reliance on scoop-and-toss restructuring that pushed off debt service repayment for near-term budget relief contributed to the junk-rated district’s credit slide and punishing borrowing costs.

“We are still finalizing the structure and timing of the issuance,” Passman added. “The underwriting team has not yet been finalized.”

The Chicago Board of Education signed off on the borrowing authorization at its monthly meeting Wednesday. The bond resolution reports the potential refunding of 2002, 2006, 2008, 2009, and 2013 debt. The earlier maturities are likely callable but later maturities would have to be refunded with taxable bonds because the federal tax legislation adopted late last year eliminated advance refundings.

The junk-rated district pays a steep penalty to borrow but the new state aid and additional city funding buoyed market perception and the district shaved more than 200 basis points off its last sale – a $1.025 billion issue that sold late last year – compared to its $500 million sale in July. The state finalized the new funding later in the summer.

The district is receiving $300 million in new state aid annually from a revised school funding formula and to help cover its pension contributions. The state also gave the district an additional $130 million in tax levy capacity and the city is providing $80 million to help cover public safety costs.

Gov. Bruce Rauner, however, has proposed in his fiscal 2019 budget shifting some state pension contributions for teachers’ pensions to school districts, a move that would cost CPS more than $200 million.

Spreads late last year initially ranged from 230 to 260 basis points to the Municipal Market Data top-rated benchmark before they were repriced by 5 to 20 bp better. That compared to roughly 480 bp spreads seen in the July issue.

The district’s standing with investors has also been helped with its attachment on some GO-alternate revenue bonds backed by general state aid of a post-default intercept provision that would direct aid directly into an escrow.

The district’s short-term borrowing remains costly. It is paying 70% of the three-month London Interbank Offered Rate plus a spread of 330 basis points on the latest tranches – a $203 million issue and a $145 million tranche – that sold Jan. 5 and Feb. 13, respectively. JPMorgan (JPM) purchased the tax anticipation notes that mature in December 14.

The cost is up from tranches that sold earlier in fiscal 2018 at a rate of 70% of one-month LIBOR plus a spread of 275 basis points. As of March 1, the district had $847 million of TANs outstanding including $247 million that mature April 2.

The district projects ending fiscal 2018 on June 30 with a $250 million cash balance although $950 million of TANs will be outstanding. The district this fiscal year trimmed its reliance on short term borrowing to $1.1 billion from $1.55 billion.

Fitch Ratings last year raised its rating by one notch to BB-minus and assigned a stable outlook. S&P Global Ratings shifted its outlook to stable from negative on its B rating. Moody’s Investors Service rates the district at B3 and revised its outlook to stable from negative.

Kroll Bond Rating Agency, the only rating agency that rates the district in investment-grade territory, revised its outlook to positive on its BBB and BBB-minus ratings.

Market participants say while the new funding provides needed salve for its fiscal pressures, the credit remains distressed and the district faces expense and labor pressures with little additional room to further raise new revenue.

Chicago Public Schools (CPS) is heading into the next annual budget cycle for the 2019 fiscal year that begins on July 1, 2018. In a letter from CEO Janice Jackson to principals, CPS announced that individual school budgets will be delivered to principals in early April, much earlier than recent years. Last year, principals received their school budgets in July due to delays from the State budget impasse. The District’s fiscal year runs from July 1 through June 30 and the District must approve an annual budget within 60 days of the start of its fiscal year, or by August 30.

As CPS prepares its FY2019 budget, the Civic Federation takes a look at what has happened with CPS finances since the District passed its FY2018 budget in August 2017.

Amended Budget
The Chicago Board of Education approved the CPS FY2018 budget on August 28, 2017 based on two funding assumptions: 1) that the State would provide $300 million in additional funding through a proposed evidence-based statewide school funding formula set forth in Senate Bill 1; and 2) that the City of Chicago would provide $269 million from an unidentified source. At the time, Senate Bill 1 had been approved by the Illinois General Assembly, but Governor Bruce Rauner issued an amendatory veto that significantly changed portions of the funding formula and would reduce funding levels for CPS. The Illinois Senate voted to override the Governor’s amendatory veto but the House failed to override in a vote taken on August 28, 2017, the same day the Board of Education voted on the CPS budget. It was unclear whether CPS would receive the funding it was counting on.

Another version of the statewide school funding bill, Senate Bill 1947 House Amendment 5, consisted of the revised formula along with terms reached through a compromise between the Democratic majority leaders and Republican minority leaders, which are described in this blog post. The bill passed the House on August 28, 2017 and the Senate on August 29, 2017. The Governor signed it into law on August 31, 2017 as Public Act 100-465.

As a result of the new statewide school funding formula, CPS received an additional $450 million from the State of Illinois consisting of $221 million to pay the normal cost contribution to the Chicago Teachers’ Pension Fund, $130 million through new authority to increase a property tax levy specifically to fund teacher pension costs, $76 million in additional State Aid revenue, $19 million in State grants and an additional $4 million in State Aid above the originally anticipated amount. All of these funding sources will be recurring revenues.

Additionally, the City of Chicago pledged to provid CPS with $80 million for school security and other student safety costs.

CPS incorporated these funding changes into an amended budget approved by the Chicago Board of Education on October 25, 2017.

The historic new school funding formula and the additional funding for Chicago teachers’ pensions served as a major assist to the District’s operating budget. However, CPS still remains challenged with severe financial problems due to its reliance on short-term borrowing, its long-term debt burden and increasing pension costs. We discuss these issues below.

Long-Term Debt
As a result of the increase in funding for CPS from the revised school funding formula, several ratings agencies adjusted their ratings of CPS debt. Fitch Ratings upgraded the Chicago Board of Education to BB- from B+ and changed the rating outlook from negative to stable in October 2017. In a statement, Fitch said, “prospects for restoration of operating balance and reserves have improved with the passage of a new state funding framework” and the “revised funding framework should improve the amount, timing and potential volatility of state aid to CPS.” Standard and Poor’s, Moody’s and Kroll’s all adjusted their outlooks on CPS debt from negative to stable.

As of November 1, 2017, CPS had approximately $7.1 billion in outstanding long-term general obligation debt, consisting of $6.1 billion of fixed rate debt and $1.0 billion of variable rate debt.[1] On November 16, 2017, CPS put up for sale an additional $1.025 billion of general obligation bonds. This brought the total of CPS’ outstanding long-term direct debt to $8.3 billion. The current outstanding debt includes $7.3 billion in general obligation debt, approximately $800 million in Capital Improvement Tax bonds and approximately $117 million in bonds issued by the Chicago Public Building Commission and owed to the Board of Education.[2]

On March 21, 2018, the Chicago Board of Education approved an additional $600 million of borrowing to refund existing bonds to move them from variable interest rates to fixed interest rates. As reported by the Chicago Tribune, the purpose of the bond issuance would be to refinance debt at a lower interest rate to produce short-term savings, which could help avoid budget cuts. Official details on the bonds will become available if and when CPS moves forward with the bond sale.

Short-Term Borrowing
CPS has relied on short-term borrrowing in recent years to cover cash flow needs in order to make payroll and large debt service and pension payments while awaiting two lump sum payments from property taxes in August and March. In the past, CPS used its reserves to bridge the gap between incoming revenue and outgoing payments. However, CPS has depleted its budgetary reserves, and since FY2015 has used Tax Anticipation Notes, or short-term loans, to generate cash while awaiting tax revenues.

During the 2017 fiscal year, CPS issued $1.55 billion in Tax Anticipation Notes to bridge the gap while awaiting the District’s property tax revenue from its tax year 2016 property tax levy in the amount of $2.34 billion. The District had $950 million remaining in outstanding Tax Anticipation Notes at the end of FY2017, which the District paid off in August 2017 after receiving a property tax revenue installment.[3]

CPS authorized the issuance of another $1.55 billion in Tax Anticipation Notes during the current 2018 fiscal year. As of December 15, 2017, CPS had issued $600 million in Tax Anticipation Notes and anticipated issuing an additional $700 million in short-term notes throughout the remainder of the fiscal year for an estimated total of $1.3 billion.[4] The CPS FY2018 budget anticipated that the Tax Anticipation Notes would cost $79 million in interest.

CPS also issued $387 million in Grant Anticipation Notes in FY2017 to cover periods of late grant payments from the State of Illinois. The District paid them off in September 2017.[5]

Short-term borrowing is an expensive alternative to using reserve funds to bridge revenue gaps. However, with depleted reserves and unreliable State funding, it is possible that CPS will need to rely on short-term borrowing again in fiscal year 2019.

Reserves
The CPS Comprehensive Annual Financial Report for FY2017, which ended on June 30, 2017, was released in January 2018. This report includes audited year-end measures of the District’s general operating reserves, or fund balance. We look at the District’s unrestricted general operating fund fund balance, which consists of net assets in the operating fund that are not restricted, assigned or committed for any specific purpose by formal or informal action taken by the Board or other government officials.

The chart below shows the level of unrestricted general operating fund balance over the past five years. At year-end in FY2013, the fund balance was $819.0 million, then decreased over the next two years. In FY2016 CPS ended the year with an unusual negative unrestricted fund balance of $227.0 million. It declined even further to negative $354.9 million by the end of FY2017.

It is important to understand that the negative unrestricted general operating fund balance is offset by restricted general operating fund balance and fund balance levels in the District’s other debt service and capital funds. Therefore, the overall fund balance for all governmental funds is not necessarily negative. But the negative unrestricted general operating fund balance reflects the extent to which the District’s structural deficit has had a negative impact on its ability to perform day-to-day operations.

The FY2018 fund balance figures will not be available until after the end of the current fiscal year on June 30, 2018. However, CPS projects having a negative cash position during the majority of FY2018.[6]

Chicago Public Schools CPS balance, Civic Federation
CPS’ depletion of its reserves is due to a consistent structural deficit wthin the District’s general operating fund. The following chart shows the year-end deficits CPS has had over the past five years. These figures reflect expenditures exceeding revenues each year between FY2013 and FY2017, hitting a low in FY2015 of negative $710.8 million and improving to negative $207.2 million by the end of FY2017.

In November 2017, the District expected its FY2018 general operating deficit to improve to negative $57.3 million, as long as the State grants expected for FY2018 are paid on a timely basis.[7]

CPS owes a total of $784 million for its employer contribution to the Chicago Teachers’ Pension Fund in FY2018. The additional pension funding from the State of Illinois for the normal cost of the Chicago Teachers’ Pension Fund as well as the increase in the tax rate at which CPS is authorized to levy property taxes for purposes of funding teacher pensions helped boost funding to make this payment. According to CPS finance officials, the State contributed a total of $233 million, including $12 million for the State’s annual contribution and $221 million to cover the pension normal cost approved in Public Act 100-465. CPS estimates raising $405 million through its dedicated pension levy. This leaves a remaining balance of $146 million that CPS will need to contribute to the pension fund this year.

To be sure, these funding increases help. But CPS has looming pension payment increases ahead. The following chart from the CTPF actuarial valuation report for FY2017 illustrates the pension funding increases expected over a period of 40 years.

As described in a previous blog post, changes in assumptions on the pension fund’s actuarial liability resulted in an increase of nearly $1.1 billion and the actuarial funded ratio fell to 50.1% from 52.5% in FY2017. CPS is projected to owe $808.6 million for its employer contribution to the pension fund in FY2019, of which CPS will need to cover $569.7 million and the State of Illinois will cover the remainder.

The Civic Federation looks forward to the release of the final CPS FY2019 budget this summer.

Moody’s Investors branded the project that Emanuel calls a “game-changer” for Chicago as “credit negative” because it will “increase leverage and airline costs above those of airport peers, weakening O’Hare’s competitive position and airlines’ profitability.”

O’Hare has $7 billion in outstanding general airport revenue and passenger facility charge debt even before the the new round of borrowing for the expansion.

If, as expected, the city borrows against future landing fees, terminal rents and concession revenues to bankroll the entire project, O’Hare’s debt load will rise to $14.5 billion by 2022.

That’s “well above the increase” at other major airports, Moody’s said.

“Airline costs most acutely pose risk to connecting traffic, which does not need access to the local Chicago market and can be served by another connecting hub airport,” Moody’s wrote.

“Although airlines can pass increases to passengers, we think cost increases that are significantly higher than the increases of rival airports will diminish profitability and increases the risk of losing connecting services in the future.”

The “credit negative” label is certain to exacerbate Emanuel’s running feud with Moody’s.

The mayor was so incensed by Moody’s junk bond rating he demanded that Moody’s stop rating Chicago bonds.

Although O’Hare already has a mountain of debt, Chief Financial Officer Carole Brown has assured aldermen that the massive expansion plan poses no credit risk either to the airport or the city.

For three weeks, American Airlines was alone among airlines in opposition to the expansion because of the five additional gates awarded to hometown United Airlines.

But American got on board after Emanuel made a hazy promise to speed construction of three additional gates used by all carriers that favor American because they’re located at the end of an American concourse.